A paramount and popular investment principle is to “buy low and sell high.” However, this somewhat simplistic financial concept is probably confusing to many investors — especially when investing in residential mortgage assets. One practical key to buying low and selling high when residential loan vehicles are involved is to locate and invest in loans (and also related mortgage assets) that are underpriced relative to similar investments.
Please keep in mind that buying undervalued mortgages is not the same thing as investing in underpriced homes. The focus in this article is to provide an overview of when and why residential real estate financing vehicles can be undervalued (presenting the opportunity to buy low) and identify circumstances where under-performing residential mortgage portfolios can be converted to re-performing real estate loan portfolios (creating the potential to sell high).
Re-Performing Portfolios and Underpriced Residential Mortgages: Why and When?
In the quest to find undervalued mortgages and transform them into higher-priced assets, multiple (and often contradictory) financial circumstances are likely to be present. With an emphasis on the why/when aspects, here are five examples:
Mishandling of Loan Modifications by Mortgage Servicing Companies — In the period both preceding and following the most recent financial crisis, one of the most prevalent and controversial activities involved how mortgage servicers handled (or mishandled) borrower attempts to modify their mortgages. With non-bank specialty mortgage servicing companies, the emphasis on loan workouts, foreclosure avoidance and improved collections can improve loan performance and contribute to re-performing loans (mortgages that were once delinquent but are now current).
Pricing Discrepancies Involving Non-Agency Mortgage-Backed Assets — For several decades, securitized mortgages (marketable securities consisting of mortgage pools) primarily featured portfolios backed by federal agencies. Even though non-agency residential mortgage-backed securities (RMBS) are now increasingly used, valuations of non-agency versions are not always consistent and accurate. Underpricing scenarios provide periodic opportunities to “buy low.”
Forced Sales by Institutional Investors — RMBS investments often trade in large blocks as institutional investors buy, sell and otherwise adjust their portfolios. It is not unusual to encounter selling activity by institutional investors that are forced to sell positions due to circumstances such as rating downgrades or a sudden need to raise capital. Such high-volume transactions can artificially depress prices on a temporary basis. This can result in underpriced loans and provide another opportunistic situation for investors with ample capital.
Lack of Understanding About Some Residential Mortgage Components — The capability to assign accurate values to residential mortgage loans depends on the complex analysis of multiple financial concepts such as potential loan prepayments, delinquent payments and foreclosures. Several new components of mortgages make the valuation process even more challenging. For example, residential mortgage-related assets now include servicer advances, call rights and excess mortgage servicing rights (MSRs). Failure to properly appraise these diverse mortgage components can result in missed investment opportunities. However, astute investors can use the same circumstances to find undervalued residential loan assets.
Fluctuations in the US Housing Market and Economy — The overall economy and housing market are both responsive to a complicated mix of factors that includes increases in disposable income, unemployment rates, new construction activity, Federal Reserve changes in interest rates and the ability of borrowers to obtain mortgages from lenders. In turn, these factors can also influence residential loan values through circumstances such as delinquent payments and foreclosures. While the credit crisis beginning around 2007 shed a negative light on several aspects of residential mortgages, this watershed event also provides a practical illustration of how mortgage investors can periodically locate undervalued loans when economic circumstances suddenly change.
How to Find and Invest in Undervalued Residential Mortgage Loans
Housing represents a $25 trillion asset in the United States. The total debt for single-family properties is about $10 trillion. Most (about 70 percent) of the financing for residential real estate is included in securitized assets like RMBS. Of course, finding the debt-related assets that are underpriced is an imposing challenge.
New Residential Investment Corp. is a real estate investment trust (REIT) that actively manages assets that are primarily related to residential real estate. The Company is strategically prepared to identify undervalued mortgages and capitalize on periodic pricing discrepancies in the securitized mortgage loan market. New Residential is designated as a qualified mortgage servicing rights owner in all U.S. states and is approved to act in a servicing capacity for major federal housing agencies.
About New Residential Investment Corp. — NYSE Ticker Symbol: NRZ
New Residential is managed and advised by Fortress Investment Group LLC, a global alternative investment manager. The Company is publicly traded on the New York Stock Exchange, operates as a qualified REIT and is based in New York. As of February 4, 2019, New Residential’s stock market valuation is $6.2 billion ($17 per share).
Michael Nierenberg is President, CEO and Board Chairman of the Company. New Residential was created by a spin-off from Newcastle Investment Corp. in 2013 and operates as a separate entity. The Company’s investment portfolio primarily features specialized residential real estate assets such as excess mortgage servicing rights, servicer advances and residential mortgage-backed securities.